Comparing Contagions

Unless you've been island-hopping to soak up the Mediterranean sun, Greece probably hasn't been on your mind much—until recently that is.

Suddenly, Greece is the center of a financial storm roiling European debt and equity markets, and that some fear will spread worldwide. Greece and a few other European countries collectively known as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) have in recent months seen interest rates spike to varying degrees (a lot in Greece, less in Portugal and Ireland, far less in Italy and Spain), debt downgrades, a €110 billion European Union (EU) and International Monetary Fund (IMF) aid package for Greece, relaxed collateral standards at the European Central Bank (ECB), and plunging stock markets. The situation in Europe has some folks with longish memories comparing the environment today to 1997-98 when investor angst was focused not on Europe but Asia as the Asian financial crisis unfolded. Considering how global stocks performed in the late nineties, investors might cheer the comparison.

Though there are undeniably holes in the Asian financial crisis/PIIGS analogy, there are many similarities as well—enough to make a worthwhile comparison of the economic and investing environment then and now. For instance, debt and currency are at the heart of both crises. In the 1990s, Southeast Asian countries got into trouble by issuing debt in foreign currencies, namely US dollars. When they were eventually forced to devalue their currencies, the cost of servicing and repaying their dollar-denominated debt went through the roof. Had their debt been in their own currencies, their problems might not have been so dire.

Unlike emerging Asian countries in 1997, the PIIGS and 11 other European countries share a common currency—the euro. PIIGS' problems aren't a result of issuing debt in a foreign currency while theirs plummets. Their debt is mostly in euros, but in some ways it might as well be a foreign currency since it's a currency they don't control. The ECB determines monetary policy for the entire eurozone, so PIIGS can't devalue their currencies to levels that would attract foreign capital or simply print their own money to repay their debt.

The collective size of directly affected countries is similar too. In 1997, Thailand, Indonesia, South Korea, Malaysia, and Singapore along with Brazil and Russia (drawn into the crisis later) collectively accounted for 8.2% of global GDP. Today, the PIIGS comprise about 7.5% of the world economy.[i] And just as folks fear PIIGS' small economic size belies the potential magnitude—the story goes PIIGS issues will infect all of Europe and eventually the world—problems in Asia were deemed "The Asian Contagion" because many feared they would spread worldwide. They didn't.

Then there's the international response. In 1997, the IMF provided Thailand, Indonesia, and South Korea with over $36 billion in loans and helped arrange an additional $82 billion in international aid. This year's aid package for Greece includes €30 billion from the IMF and €80 billion from other EU members. Adjusted for exchange rates fluctuations and global inflation, Greece's bailout package is a full third smaller than Asian countries received in the 1990s.[ii]

The dollar was strong then too as it is today, and the currencies of affected countries were in freefall. Though down significantly of late, the euro's decline has been orderly and not nearly as severe as the Thai baht, Indonesian rupiah, Malaysian ringgit, and Philippine peso in 1997.

Global economic growth is forecast to be even stronger in 2010 and 2011 than it was in 1997 and 1998. Real global gross domestic product (GDP) grew 4.0% in 1997 and 2.6% in 1998. Forecasts have 2010 worldwide GDP growing 4.2% and 4.3% in 2011. Somewhat ironically, today's robust economic growth is being fueled by many of the countries that suffered in the Asian Financial Crisis. In 1998, the economies of Thailand, Indonesia, Malaysia, the Philippines, and Singapore (known as the ASEAN-5) collectively contracted 8.4% in US dollar terms. In 2010, those same countries are expected to grow by a very healthy 5.4%.[iii]

Lastly and most important to most investors is the stock market response. US and global stocks started 1997 strong. By mid-February, the S&P 500 was up 10.5% for the year. The MSCI World Index gained about 3.3% over the same period. The S&P and World suffered pullbacks of 9.4% and 6% over the next two months—not unlike the mini-correction global stocks suffered in early 2010—only to rebound and reach new highs within weeks.[iv] But just as PIIGS stocks are suffering more than other markets today (stocks in Greece, Portugal, Italy and Spain are all off about 30% or more in US dollars from their recent highs, led by Greece down over 50%), Southeast Asian shares were hit much harder than the rest of the world in 1997-98 with Thailand, Indonesia, Malaysia, and South Korea down 80-90% from peak to trough in US dollars.[v] Even Thursday's tremendous intraday market drop (the S&P 500 fell 8.6% midday but closed down just 3.2%) was mirrored in 1997. On October 27, 1997, the S&P 500 fell by a similarly striking 6.9%.[vi]

So how is any of this good news? Well, consider how stocks finished those tumultuous years. Despite fits and starts, the turmoil surrounding the Asian Financial Crisis, and the eventual Ruble Crisis that engulfed Russia and took down US hedge fund Long-Term Capital Management in 1998, the S&P 500 and MSCI World Index absolutely soared, finishing 1997 up 33.4% and 16.2% and 1998 up 28.6% and 24.8% respectively.[vii]

History never repeats itself exactly, but the similarities are often more striking than you might think. Just because stocks surmounted Asian contagion fears in 1997-98 doesn't mean European contagion concerns will be so easily overcome in 2010 and beyond. But the comparison does show we've persevered though similar and in many ways even more challenging issues in the past and have the ability to again. Then, developments in Asia were troubling to be sure but were trumped by positives outside the region, which drove global shares higher. Today, PIIGS concerns are real, but so are positive factors like the overwhelming tendency for second years of bull markets to be positive; gangbusters emerging markets economic growth; tremendous new end markets for goods and services developing in places like China, India, and Brazil; incredible productivity gains boosting corporate earnings, which are exceeding expectations at a record clip; attractive valuations for stocks; exceptionally accommodative monetary policies worldwide; healthy corporate balance sheets with near record amounts of cash to deploy; and greatly improved conditions in credit and financial markets generally. With these factors providing a tailwind to global stocks, there's no reason to think the PIIGS portend economic or stock market doom.